How Michael Dell Shortchanged Shareholders While Doing
Michael Dell, founder and chief executive
officer of Dell Inc., speaks during the 2015 Dell World
Conference in Austin, Texas.
Photgraph by Matthew Busch — Bloomberg via Getty
Our legal analyst appraises Dell’s
On Monday, when a
Delaware court ruled that Dell Computer’s then-CEO Michael Dell and
Silver Lake Partners underpaid shareholders by about $6 billion, or
22%, when they took computer giant Dell Inc. private in 2013, many
readers were left scratching their heads.
Those of a
pro-shareholder bent asked: Who were the dastardly board members and
financial advisors who went along with this highway robbery? Others,
adopting the dealmakers’ perspective, wondered: Who exactly was the
mystery buyer champing at the bit to pay $31 billion for Dell in 2013,
when the market for Windows PCs was in free fall, when tablets and
smartphones were on the march, and when enterprises were moving toward
cloud services, building their own servers, or buying them from
cut-rate Taiwanese and Chinese outfits?
But the ruling doesn’t
actually find that the buyout team did anything wrong, nor does it
imagine that any real world buyer was waiting in the wings prepared to
fork over $17.62 per share—the judge-determined “fair value” for the
company—rather than the $13.96 per share, counting certain dividends,
that the buyout group paid. (The highest competing bid at the time,
from investor Carl Icahn and Southeastern Asset Management, was valued
at a little over $14 per share, but had arguable downsides in its
Remember that the price
Michael Dell’s group paid represented a 28% premium over the stock
price ($10.88) on the day before news of the merger deal first leaked
to the press in January 2013, and a 39% premium over the 90-day
average stock price ($9.97) before that date.
Remember also that the
buyout group bid won the endorsement of proxy advisory firms
Institutional Shareholders Services and Glass Lewis & Co., as well as
rating agency Egan-Jones Rating Co.
And remember, finally,
that bad earnings news kept rolling in for both Dell and its industry
throughout the bidding process, prompting Indigo Equity Research in
August 2013, for instance, to call Dell a “sinking ship,” and to label
Michael Dell’s turnaround plan as “fundamentally flawed.”
No Dell officer or board
member was found to have breached any fiduciary duty to shareholders
in Monday’s ruling, for instance, and it certainly accuses no one of
In fact, Vice Chancellor J. Travis
Laster of the Delaware Chancery Court actually had some positive words
for the company board’s conduct. Its special merger committee and its
advisors—mainly J.P. Morgan Chase and Evercore Group—actually “did
many praiseworthy things,” Laster wrote, “and it would burden an
already long opinion to catalog them.” (His
was 114 pages.)
Nevertheless, the auction
process the special committee ran, though not crooked, simply didn’t
end up providing shareholders with “fair value” for their shares as
Delaware law defines it, Vice Chancellor Laster concluded.
The result may seem
counterintuitive. But as Laster noted, “The concept of fair value
under Delaware law is not equivalent to the economic concept of fair
market value. Rather, the concept … is a largely judge-made creation,
freighted with policy considerations.”
In this article, I’ll try
to shed a little light on this puzzling, seemingly paradoxical
So if there was no breach
of duty, why did the plaintiffs win?
This was an appraisal
suit, not a breach of fiduciary duty suit. The only thing at issue in
an appraisal suit is whether plaintiffs received “fair value” for
their shares when the merger was approved in September 2013. The issue
of “why” they may not have received fair value is not the question.
The definition of fair value is vague; it’s the shareholder’s
“proportionate interest in a going concern,” i.e., his shares’ “true
or intrinsic value” under all the circumstances.
What’s an appraisal suit?
In the olden days, if a
company wanted to merge, it needed the approval of 100% of its
shareholders. That stopped being the case over a century ago. Today,
for a Delaware corporation, you generally only need 51% approval.
But in a nod to the past,
dissenting shareholders who feel they’ve had an all-cash offer crammed
down on them are entitled to sue for an appraisal. The court then
determines the fair value of their shares, and that’s what they get,
in lieu of the negotiated merger price. Theoretically, there’s a risk
that the court could find the fair value to have been lower than the
merger price, but that’s exceedingly rare.
In any case, in addition
to the court-determined fair value price, the plaintiff also gets
accrued interest of 5% over the federal funds rate. Some critics think
that’s too much, since it means there’s relatively little downside to
bringing an appraisal suit. Even if you lose—i.e., the judge thinks
the original merger price was fair—you’ll still get what you would’ve
gotten if you’d approved the merger, plus interest.
How will Dell pay the $6
billion that shareholders were underpaid?
They won’t have to pay
anything remotely like that. Only shareholders who vote against a
merger are entitled to bring an appraisal suit, and a fairly small
number did in Dell’s case.
As it happens, the largest plaintiff
among the dissenters, T. Rowe Price Group, inadvertently voted all its
shares for the merger, though it meant to vote against, so it ended up
being ineligible for the appraisal. (That’s a long story, told in a
Vice Chancellor Laster published
back in March.)
Wall Street Journal estimates
that Dell will only have to pay about $35 million to the remaining
appraisal plaintiffs as a result of Monday’s ruling, with about $25
million of that going to the hedge fund Magnetar Capital. (For more on
Magnetar’s strategy, see
Are appraisal suits
They didn’t use to be,
but have become so in the past 15 years or so, rising to “over 20 a
year in recent years, or close to one-quarter of all transactions
where appraisal is possible,” according to a recent
by Columbia Business School professor Wei Jiang and three others. They
seem to have gotten turbocharged by a ruling in 2007 that permitted
people—in practice, mainly hedge funds—to buy shares after a merger
has been announced and for the express purpose of voting against it
and then seeking an appraisal. This practice is called appraisal
Today, seven hedge funds
account for almost 50% of the dollar value of all appraisal
litigation, according to Jiang’s study, led by Merion Capital,
Magnetar, Merlin Partners, Ancora, and Quadre Investments.
Are these suits abusive?
Plaintiffs have a high rate of success in appraisal suits, especially
in those involving management buyouts and private equity deals, making
it hard to label them nuisance suits. Maybe the prospect of these
suits will spur controlling shareholders and insiders to treat
minority shareholders more fairly. But the Delaware house did recently
pass a bill that would take modest steps to reduce the number of these
suits. Experts disagree over whether this bill would achieve its
goals, though—some argue it could even backfire, spurring even more
Doesn’t the judge have to
at least give deference to the negotiated merger price, rather than
just setting his own?
No. Under the law, in
fact, the judge is not supposed to do that. He’s to make a fresh
determination. Now it’s true that if it’s a completely arms-length
transaction—a merger with unaffiliated third-parties—judges do, in
practice, seem to treat the merger price as a very good indicator of
the stock’s fair value. But in management buyouts—where inside
information and friendships and psychological sensitivities all cloud
the picture—there seems to be almost the opposite presumption.
If there’s a bidding
process, like there was in Dell’s case, why isn’t the winning bid, by
definition, the “fair value” of the shares?
Vice Chancellor Laster
felt that the market for selling a going concern is “unavoidably less
efficient” than the market, say, for a stock on an exchange. “The M&A
market has fewer buyers and one seller, and the dissemination of
critical, non-public due diligence information is limited to
participants who sign confidentiality agreements,” he wrote.
Here, at the early stages
of discussion, he stressed, the board spoke to only two prospective
buyers—Silver Lake and Kohlberg Kravis & Roberts—and KKR dropped out
early. It then reached out to Texas Pacific Group, but TPG wasn’t
But the company was also
shopped around after the signing.
Right. Here’s what
happened. Dell tasked Evercore with shopping the company for 45 days—a
so-called “go-shop” period—and incentivized Evercore, with the
prospect of a success fee, to find one. Among the best prospects
Evercore approached were HP, which wasn’t interested, and Blackstone.
Blackstone made a bid,
but then dropped out. Eventually, Carl Icahn (with Southeastern Asset
Management) also bid.
offer caused Dell to postpone and then adjourn its originally
scheduled shareholder’s meeting in July 2013, recognizing that Icahn’s
proposal might win.
The buyout group then
sweetened its offer and won the vote in September.
What did Vice Chancellor
Laster think about that? He found that, for a variety of reasons, “MBO
go-shops rarely generate topping bids,” so that the damage done by the
absence of more competition at the pre-signing phase could never be
overcome. The inherent problems with MBO go-shops include the fact
that “incumbent management has the best insight into the company’s
value, or at least is perceived to,” and many prospective buyers are
reluctant to outbid an insider, like Michael Dell, out of fear of
being branded as a hostile takeover artist.
How did the judge
calculate Dell’s value?
To begin with, and
importantly, he refused to credit “LBO pricing models,” which the
special committee’s advisors had, indeed, used when courting potential
MBO partners. In those, the advisor backs into a price that will offer
a financial buyer the prospect of earning a fat return on investment
of at least 20% over the ensuing years. Laster felt this resulted in
an artificially low price.
Instead, Laster used a
“discounted cash-flow model” (DCF)—where you compute the expected cash
flow over a period into the future and then compute the present value
of that cash flow.
Of course, choosing to
use a DCF model hardly ends the discussion. Using DCF models, the
plaintiffs’ expert, Bradford Cornell of the California Institute of
Technology, computed a fair value share price of $28.61, while the
defendants’ expert, Glenn Hubbard, dean of Columbia’s business school,
arrived at $12.68.
grappled with these competing approaches—which produced valuations
that were $28 billion apart—and ultimately came up with $17.62 per
share as the best figure.
Is Vice Chancellor Laster
He’s considered to be
brilliant. “He’s an extraordinary judge who is scrupulous about
getting the law right, and has the courage to do that even when it
angers powerful people,” says Minor Myers, a Brooklyn Law School
professor who has studied appraisal suits. “He also understands human
nature. He’s able to see: What incentives does this person face? Why
might that have worked well in certain situations, and why might that
have misfired in certain situations?”
But Laster has faced
criticism that he has an excessive desire to make headlines.
Will there be any
I don’t know. Attorneys
for the parties did not return phone calls seeking comment for this